This article, by Stephen Craft, was originally published in the September 2016 issue of InTheBlack magazine. View the original article here.
Why value pricing is the new billable hour
For professional services firms, value billing can deliver higher margins and more satisfied clients. But how do firms make the transition?
John Chisholm is a third-generation lawyer. In a career spanning 37 years, including 18 as a partner and five as chief executive, he has witnessed firsthand the innovations that have reshaped his industry – from the rise of legal process outsourcing to the advent of international mega-firms such as K&L Gates, which absorbed his former practice, Middletons, in 2013.
Yet amid all this change, one aspect of legal practice remains unchanged from his grandfather’s day: time-based billing, driven by the humble time sheet.
It isn’t only lawyers who continue to bill in the same way as in the 1950s. Many accountants, engineers, IT consultants and other professionals still charge by the hour, even if their time sheets are now on screen, rather than on paper.
So, why has time-based billing persisted in the professions for so long? And perhaps more importantly, could you create higher margins and more satisfied clients by doing things differently?
Are you leaving value on the table?
“Billing by time is just a dumb model,” says Chisholm.
“There are only 24 hours in a day, so that’s the most I can charge. I could be leaving a lot of value on the table – in five minutes, I could save you $50 million in tax.”
The traditional billable hours model puts a ceiling on a professional’s earning potential and surrenders the benefits of recent efficiency gains. After all, the more efficiently you complete a task, the fewer hours you spend and the less you can charge.
“Any profit gains I make from investing in technology just go straight out the window,” says Chisholm.
Chisholm has now started his own business, John Chisholm Consulting, designed to help build the professional firms of the future, and has become a senior fellow of the VeraSage Institute, a US-based think tank that has advocated value-based pricing for 20 years.
The institute’s founder, Ron Baker, says pricing by value is fundamental to success in a knowledge economy.
“We can’t measure value by the amount of time someone spends on something,” he says.
“The value of the polio vaccine isn’t determined by the amount of time it took Jonas Salk to invent it.”
Instead, he argues that the value of a service is determined by the customer, not the supplier. The same service can have a very different value, depending on the customer’s needs.
“If I’m in the desert and I haven’t had water for days, a bottle of water is worth a lot, because it’s going to save my life,” Baker argues.
“If I’m home washing the dog with the same quantity of water, it’s worth a lot less. But if my basement’s flooded with water, now what’s water worth to me? Its value is negative, and I have to pay somebody to come and pump it out. In all three cases, we didn’t change the product, but the value went from almost infinite to negative, depending on the context I’m in.”
Peter Docherty is general manager of public practice at CPA Australia and a strong supporter of value pricing in accounting. He says that in a world where cloud-based automation makes accounting faster and more efficient, value pricing allows firms to increase profitability and productivity at the same time.
“We’re seeing members automating their work and reducing fees, rather than actually looking at what is the value that those services provide to the client,” says Docherty.
“But with value pricing, firms can use automation and technology to reduce the time taken without reducing how much they charge.”
Advocates argue that value pricing can also boost client satisfaction by highlighting the value the provider creates, and can provide certainty so clients can budget ahead.
Making the transition
Dr George Beaton is the founder of Beaton Research + Consulting, which provides advice to the whole spectrum of professional services firms. He says that while accountants are still well ahead in switching to value pricing, law firms are starting to catch up.
In a recent study, Beaton Research found the proportion of legal work charged by the hour among top-tier and mid-tier Australian firms has fallen from 80 per cent to 74 per cent over the past three years, with a further drop to 60 per cent forecast for the next three years.
He says that an intensively competitive legal market across the Asia-Pacific is encouraging firms to experiment with alternative pricing models.
“Many law firms are seeking to work with their clients to find better pricing ways, to create more value for the client, which means more certainty and a better indication of the commerciality of the fee they are paying,” says Beaton.
“To stay profitable, firms have to adjust the way they practise and [have to] allocate their resources more scientifically to keep up in this new, more efficient environment.”
As Beaton’s comments suggest, the transition to value pricing usually takes time and effort. Chisholm says it involves fundamentally restructuring the way firms measure, reward and value their work.
“It’s a business model change, not just a billing model change,” he says. According to Chisholm, legal services is now a buyer’s market, giving firms little option but to evolve.
“Until recently, most clients accepted there wasn’t much choice,” he says. “Now they realise there are a lot of choices, so clients have the upper hand.”
In this changed landscape, value pricing can be a genuine point of difference. As Chisholm notes: “Those law firms who have done it, I speak to their clients and their clients just love it.
The path to value pricing
Understand what value really means to your clients
The value of a service is simply the value your clients place on it, so experts say the first step is to have an in-depth conversation with each customer about their needs, goals and expectations.
VeraSage Institute founder Ron Baker recommends you start by explaining that you are going to offer them price certainty, then gain a thorough understanding of the scope of the work they need from you and its value to them.
“There’s not a customer alive who doesn’t want to know the price of something before they buy it,” says Baker.
“You can easily get a customer to move over to the new pricing method if they know they’re going to get price certainty. We’ve seen this happen as quickly as three months.”
Create a value council
Not everyone is cut out to be a pricing expert, and professionals often tend to undervalue their services. To overcome this issue, Baker recommends creating a value council, bringing together leaders from across the firm as well as outside experts.
“All authors and actors have an agent, because they can get them a better price than they can get themselves,” says Baker.
“The value council acts like an agent, so that you don’t sell yourselves short. They’re the ones that are going to understand the value and price for it.”
Build a flexible pricing model
The next step is to create pricing options for each customer or group of customers, depending on the level of service they want. Baker recommends the “Goldilocks pricing” model: offering three options, such as American Express’s green, gold and platinum cards. That allows customers to choose their own trade-off between price and value.
Higher-priced options can offer a range of extra benefits, such as unlimited access to meetings and telephone calls, guarantees on response times for client queries or regular meetings with senior partners.
Baker also recommends firms offer money-back guarantees as a mechanism for increasing both client satisfaction and the perceived value of the service.
“Offering a guaranteed service can get you a price premium, because a service that’s guaranteed is worth more than one that isn’t,” he says.
“Structuring payment terms around a customer’s cyclical cash flow can also be attractive to seasonal customers – and can also be worth a premium.”
But what if some clients just won’t accept your new pricing model? Baker says that if your reasoning is sound, you shouldn’t necessarily change your prices to keep just a few customers.
“It’s usually not that the price was wrong,” he says, “but that the customer is the wrong fit.”
Beware of scope creep
Now that you’re charging for the value you create for clients, rather than the time you spend, it’s important to charge appropriately for the value you deliver. That makes it essential to define and track the scope of the services you provide. If that scope increases, you need to let the client know immediately and adjust accordingly.
But that doesn’t necessarily mean charging more. “Everybody thinks that a scope creep automatically means a price change; it doesn’t,” says Baker.
“It could mean just a deadline delay or a quality change.”
Throw away the time sheets
Baker insists that to make the transition successfully, firms need to let go of their dependency on time sheets. For many, this can be the hardest step of all.
“If all you do is implement fixed pricing or option pricing, but you keep the time sheets, you’ve still got knowledge workers chained to the desk and worrying about the time they put in,” says Baker.
Chisholm agrees. “You get what you measure – so if I measure time, I’m going to get time,” he says.
“Time-based billing is a disincentive to both innovation and collaboration.”
As a result, focusing on value delivered rather than time spent is liberating for professionals and clients alike.
“It releases young accountants and young lawyers from what I call the shackles of time sheets ... so they can use their intellectual capital much more creatively,” says Chisholm.
That can make value-based billing a distinct competitive advantage for firms looking to attract both high-quality staff and high-value clients.
The accountant: how value pricing has grown his business
Brad Golchin CPA is a director of Wise Advice and XO Accounting and a member of CPA Australia’s Public Practice Advisory Committee. XO Accounting’s journey toward value billing began when the firm first introduced cloud-based systems to make its work more efficient – only to find that those efficiencies weren’t being reflected in their time sheets.
“With billable hours, staff get rewarded for being inefficient,” he says. “A task that could have been done in 10 minutes could get recorded as one hour.”
The solution was to move to a value-based subscription model, allowing clients to choose an option that matched the level of service they need – from basic compliance to virtual CFO.
Golchin’s firm also offers a money-back guarantee. “If our client is not happy after three months, they can cancel,” he says, “so they’re not locked in for life.”
Golchin says that since implementing value pricing, his firm has grown its business by 20 per cent to 50 per cent a year, with client retention improving markedly.
“They are generally happier,” he says, “because there are no surprises and no arguments with the fees.”
To make the changeover successful, he suggests putting a communication and marketing plan in place to educate clients on how the different pricing system works. You also need to educate clients to interact with an automated system.
“If a client comes in with a shoebox full of receipts and paper,” he adds, “it’s obviously not going to work."